Lula’s interest rate fight will decide future role for BNDES
There are confusing signals about what the role of BNDES will be under the new Lula administration. Will the bank continue to stimulate more private sector funding for project and infrastructure finance? Or will it u-turn to the days of heavily funding large corporates?
It hasn’t taken long for an existential battle to break out that will determine the course of President Ignacio Lula de Silva’s third administration. After correctly diagnosing the country’s sky-high interest rates as a break to economic development, Lula has prescribed that the best way to lower interest rates is to directly attack the central bank’s independence – and governor – and articulate a return to the fiscally expansionist role of state bank BNDES in the economy.
Unsurprisingly, Lula’s speeches – backed up by comments among his economic team and the new administration of the state development bank BNDES – have spooked the markets, led to an increase in the expectations of inflation, and meant that the central bank is now less able to lower its headline Selic interest rate for fear of losing its momentum in its fight against inflation. It has also created confusion as to the proposed role of BNDES: will the bank continue to try to with private sector finance to catalyse new project and infrastructure finance? Or will the bank go back to its much-critiqued policy of heavily funding large corporate entities as a means to create “national champions”?
A new direction or u-turn?
Lula and his new BNDES president, Aloizio Mercadante, have stated that they wish to see BNDES fund a level of disbursements equal to 2% of GDP. Crucially, they are also talking about changing the bank’s funding rate, which was reformed during Michel Temer’s brief presidency as part of new public spending limit laws, and was arguably as important a fiscal reform as the pensions reform that was to follow. Previously the government simply mandated the BNDES interest rate – which were not linked or even sensitive to free market rates – which meant that the gap between the TLP and Selic could be very wide and be a very large fiscal subsidy.
However, the proposal for the reform of the new TLJP suggests an improvement in the former strategy, albeit still the creation of new subsidised credit within the economy. The suggestion appears to be the creation of a new class of tax-exempt fixed income instruments – along the lines of the CRAs / CRIs / LCIs / LCAs that finance real estate and agricultural investment.
In a client note UBS says that the peak for the bank's loan origination in 2013-14, when it reached a yearly credit concession of more than BRL180 billion (~2% of the GDP), in which BRL170 billion was related to the corporate segment. In that period, the total system's origination in the corporate segment achieved around BRL1.2 trillion per year (ex- revolving loans), therefore, the share of BNDES in terms of new origination was close to 14%.
However, the report’s author, Thiago Batista, notes that in 2022 the total new origination for corporate (ex-revolving loans) reached BRL2.2 trillion, therefore the BRL200 billion as target would represent a participation close to 10% of the total system's origination nowadays. In terms of total outstanding loans, the market share of BNDES went down from ~20% in 2013-14 to around 9% in 2022.
BNDES ended the 3Q22 (latest available data) with a loan book amounting to BRL470 billion (BRL300 billion excluding on-lending) and total equity of BRL137 billion.
Despite the potential increase in disbursements – and rumours that the government would like to reverse last year’s privatisation of electricity company Eletrobras – the market expects that the government will continue with the pipeline of concessions for airports, ports, roads and transmission lines, as well as recently active areas such as sanitation. However, until the market receives official articulation of the government’s proposed concession pipeline it is still a matter for speculation. Lula is understood to be very keen to announce his government’s spending and investment plans as early as April this year – “he is very focused on creating his legacy and he wants to be able to show how he is going to get Brazilian GDP back towards the kind of rates he saw in his first two administrations [4.5%] as soon as possible” says one.
A focus on PPPs
Recently there have been encouraging signs that those plans are evolving away from a state-led model. On 23 March Lula demonstrated his support for working with the private sector by accepting that the need to adhere to a fiscal framework will require partnerships to create the level of investment he feels is needed to drive economic growth and development: :”If we don’t have the money in the budget we are going to get investments from the private sector to make PPPs”, he said. “We need to find ways for the economy to grow beyond that normality that everyone talks about.”
That will be music to project and infrastructure lawyers, many of whom have long seen Lula’s objection to private sector finance as an issue of terminology than ideology. “The term concession masks that fact that it’s essentially a privatisation but no-one thinks the government can finance the country’s entire project finance needs. The amount of capital needed is tremendous and so we’re expecting this administration to carry on where the last one left off.”
And not all the concessions will be brought to market by the federal government. For example the state of Sao Paulo has announced it will sell the right to build six motorways between 2023 and 2026 worth a combined value of BRL32 billion.
However, not all are convinced that Lula will end up being a pragmatic player alongside the private sector.
“Regardless of BNDES’ precise role under ‘Lula 3.0’, this provides an early sign of how Lula plans to run the economy – a bigger role for the state in the economy and a smaller role for market forces [and] there’s little sign of the ‘pragmatic Lula’ that many had hoped for,” says William Jackson, chief emerging markets economist at Capital Economics.
“The turn to BNDES avoids tackling the real problems that are constraining productivity growth in Brazil’s economy. Absent a rise in the domestic savings rate or greater borrowing from abroad, Brazil’s overall investment rate won’t increase. Higher BNDES lending will only shift the composition of investment. And there are many other problems holding back productivity, including a lack of competitiveness and an overly-large state footprint in the economy.”
Ceres, Lisboa, Associate Managing Director at Moody’s Investors Service, says that Lula’s approach to BNDES has to be seen within the broader context of similarly higher credit appetite from state-controlled banks Banco do Brazil and Caixa Economica, but she also expects more control overall.
“We expect these banks to maintain loan origination above private sector banks, a move already started some months ago,” she says. “While this time around conditions might be different from the past and instruments available to the government are not available, such as the long-term rate (TLP) and other subsidised lending products, we expect the terms and conditions to differ from the past and to be more market-friendly to attract private players as well, maybe by the extension of government guarantee.
Lisboa also argues that while the fiscal room is tight for the sovereign, these three banks are in themselves in a good position to expand credit to the economy: “Now these three public banks have much better capitalization than most of their private peers, which would allow them to support an acceleration in lending activities without the need of extraordinary support from the government in the form of capital or funding. Their asset quality metrics also are relatively better than the private peers with comfortable loan loss reserves, which helps to mitigate short-term concerns about future risk deterioration.”
However, within Brazil there seems to be less pessimism that Lula will simply return to the fiscally expansionist policy of using the public banks as a quasi-fiscal tool to drive economic growth. Partially this is due to a more nuanced understanding of the political opposition facing his administration in Congress.
“Lula will be facing a Congress where [Artur] Lira, [speaker of the Congress] is almost as powerful as Lula himself,” one bank CEO told Proximo, speaking off the record given the political sensitivity of the issue. “The government is already preparing its supporters for a more realistic approach to spending and BNDES because they just don’t have the space to be aggressive. Congress won’t accept huge changes to the TLP.”
“Lula likes to control everything and in his first two administrations he did: he controlled the congress, the senate, the central bank, the supreme court,” agrees a project finance banker based in Sao Paulo. “Now he doesn’t – he’s going to come up against political realities. Brazil has changed – the corruption scandals means Lula won’t be able to control everything like he once did. He’s not going to like it and he will make frustrated speeches about boosting BNDES’s role in the economy. But even today – look at the impact of his attacks on the central bank – they barely make news. In the past they would have been the headlines for days.”
In 2022 previous president of BNDES, Gustavo Montezano, told Proximo’s sister magazine Uxolo that he believed the BNDES strategy of financing national champions was now discredited forever. “Politicians ask me, why are we just [not financing national champions] now? Why were we spending so much for large projects with subsidies? I say you should answer that question. It made no sense – if there is a national budget let’s put it towards helping the small companies.”
Still room for infrastructure optimism
Some participants in the infrastructure markets are not just less fearful; there are also expressions that can be best characterised as optimism. Not only do they not see any likelihood of systemic mismanagement, but extra credit appetite that is focused on supporting nascent areas of the infrastructure and project finance market is seen as a potentially positive industry trend.
“There’s possibly support in Congress for creating subsidised credit – say 70% to 80% of the market rate – to support innovation in key sectors, like energy efficiency for example,” says Paloma Valeria Martins Lima, partner at Pinheiro Guimaraes in Sao Paulo who specialises in project finance. “That could combine with parallel conversations that we are having [with BNDES] around renewables to provide significant support to the industry. And if the bank keeps it’s [recent] focus on financing small and medium sized companies [rather than returning to its strategy of fostering national champions] then this could have a positive impact on the wider industry. I don’t think anyone expects the large projects to move away from having multiple different companies and multiple sources of financing.
However, as with so much uncertainty swirling around the issue it’s only natural that those, like Lima, who that have an optimistic outlook temper these with caution: “My concern is that BNDES is losing the focus on using its technical expertise. In the past few years we have been using the brilliant technical capacity that BNDES has to assist government to model projects, and how they should be structured to be auctioned in a way that brings in private parties.”
There is also optimism that the BNDES can play a central role in conservation, particularly the Amazon fund, which was suspended under the presidency of Jair Bolsonaro: “I’m meeting with the BNDES next week and I’m very interested to hear what it’s planning with the Amazon Fund. It’s a very visible issue, especially for international investors and those involved in ESG. More broadly I want to know what it plans to do around carbon – the past management team did a lot around fostering a market and I’m really hoping this team commits to fulfilling its mission as a public entity by continuing this policy and creating the continuation and stability we need to grow this new market,” says the Brazil head of ESG at an international investment bank in Sao Paulo.
Rafaela Vitoria, chief economist at Banco Inter, thinks that, ultimately, the issue of BNDES role is one of economic strategy rather than infrastructure finance: the most effective way to reduce interest rates is effective macro-economic management, rather than micro policy developments around the creation of new financing tools.
“If the government decides to lower interest rates on earmarked loans, then non earmarked loans become more expensive naturally,” says Vitoria. “The market understands that, and this is why there is some resistance from Congress to approve such subsidy because they know that it's going to be more expensive for the rest of the economy. The most effective way to sustainably reduce long term interest rates is to create a primary fiscal surplus that puts the sovereign debt dynamics on a solid downward trajectory.”